Principles of Risk Management & Insurance Exam 1

Risk

Uncertainty concerning the occurrence of a loss

Also used to identify the property or life that is being considered

Risk Management

identifies loss exposures faced by an organization and selects the most appropriate techniques

Uncertainty

situations or circumstances where such probabilities cannot be estimated

Pure Risk

When there is uncertainty as to whether loss will occur, no possibility of gain

(Your house burning down, earthquake, getting in a car accident, etc.)

Objective Risk

Measures both dimensions, the probability of loss and severity of loss - simultaneously

Actual loss vs. expected loss

Speculative Risk

when there is uncertainty about whether an event can produce either a profit or a loss (Gambling, investments, etc.)

Subjective Risk

the mental state of an individual who experiences doubt or worry as to the outcome of a given event

Ex: Some people think flying in an airplane is unsafe, some think its totally safe

Objective probability

relative variation of an actual loss from expected loss

Subjective probability

the individual's personal estimate of the chance of loss

Difference between Subjective and Objective Risk

differs from subjective risk in the sense that it is more precisely observable and therefore measurable

Risk Averse

Prefer to avoid risk, willing to pay more than expected loss to avoid risk

Risk Seeker

Prefer risk, would pay more than expected return to engage in risky situation

Probability (chance) of loss

The probability that an event will occur.

= (number expected) / (total number exposed)

Commercial Risks

Property ricks

Liability ricks

loss of business income

cybersecurity and identity theft

Human resources exposure

Foreign loss exposure

intangible property

Gov't exposures

Property Risk

Risk that property may be damaged, destroyed, or stolen

Liability Risk

the possibility of being held legally liable for bodily injury or property damage to someone else

Personal Risk

premature death, inadequate retirement income, poor health, unemployment

Burden of Risk on Society

Funds to pay for unexpected losses without insurance

Risk of a liability lawsuit may discourage innovation

Rick causes worry and fear

Peril

cause of the loss (tornado, lightening, windstorm, fire, etc.)

Hazards

a condition that increases the chance of loss

Physical, Moral, Attitudinal, Legal

Types of Hazards

Physical Hazard

A condition stemming from the material characteristics of an object

Moral Hazard

dishonest or character defects

Attitudinal Hazard

carelessness or indifference

Legal Hazard

Legal system or regulatory environment

Loss Exposure

Any situation, circumstance, unity, or object subject to a potential loss (house, car)

Whether or not a loss has occurred

Pre-Loss Objectives

Prepare for potential losses in the most economical way

Post-Loss Objectives

take action

approach losses after they happen

Non-insurance transfer

transfers risk to another party; hold-harmless clause in a contract

Pooling

To spread the losses of the few over the entire group

Law of Large Numbers

risk reduction; the greater the number of exposures, the more likely will the actual results approach the probable results

Risk Management Process

1. Identify risks

2. Measure and analyze the loss exposures

3. Select risk management techniques

4. Implement and monitor decisions

Avoid, Retain, Transfer

Major Risk Management Techniques

Loss Control

When particular risks cannot be avoided so actions are taken to reduce losses associated with them

Types of Loss Control (prevention)

Separation, Duplication, Diversification

Risk control

Avoidance

Loss prevention - duplication, separation, diversification

Separation

Involves the reduction of the maximum probable loss associated with some kinds of risks

Duplication

Spare parts or supplies are maintained to replace immediately damaged equipment and/or inventories

Risk Retention

an individual/business retains part or all of the losses that can result from a given risk

Retention level

Dollar amount of losses that the firm will retain

Active Retention

an individual is aware of the risk and deliberately plans to retain all or part of it

Passive Retention

Risks may be unknowingly retained because of ignorance, indifference, or laziness

Captive insurer

insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposure

Single-Parent captive

Association or group captive

Self Insurance

If the firm has a group of exposure units large enough to reduce risk and thereby predict losses, will not involve transfer of risk

Diversification

Results in the transfer of risk across business units, combining businesses or geographic locations in one firm can even result in a reduction in total risk

Non-diversifable risk

risk affects the entire economy or large numbers of persona or groups within the economy; fundamental risk

Enterprise Risk

All major risks faced by a business firm

Strategic Risk

Uncertainty regarding the firm's financial goals and objectives

Financial Risk

uncertainty of loss because of adverse changes in commodity prices, interest rates, etc

Systematic risk

risk of collapse of an entire system or entire market due to the failure of a single entity or group of entities

Fortuitous loss

one that is unforeseen, unexpected, and occur as a result of chance

Characteristics of an Ideally Insurable Risk

Large number of exposure units

Accidental and unintentional loss

Determinable and measurable loss

No catastrophic loss

Calculable chance of loss

Economically feasible premium

Adverse selection

Tendency of persons with a higher-than-average chance of loss to seek insurance at standard rates

Insurance

Handles an already existing pure risk

Low probability, high-severity loss exposures

Deductibles

specified amount subtracted from the loss payment otherwise payable to the insured

Excess insurance policy

insurer pays only if the actual loss exceeds the amount a firm has decided to retain

Hedging (gambling)

limit or qualify (something) by conditions or exceptions; someone else always looses

Life Insurance

Pays death benefits to beneficiaries when the insured dies

Health Insurance

covers medical expenses because of sickness or injury

Casualty insurance

whatever bit covered by fire, marine and life insurance

Financial Risk Management

Commodity Price Risk

Interest Rate Risk

Currency Exchange Rate Risk

Integrated risk management

combines coverage for pure and speculative risks

Double trigger option

provides payment only if two specified losses occur; trying to save on premiums

Emerging Risks

Terrorism (TRIPRA 2015)

Climate Change

Cyber Liability

Underwriting Cycle

cyclical pattern of underwriting stringency, premium level, and profitability

"Hard" market

tight standards, high premiums, unfavorable insurance terms, more retention

"Soft" market

loose standards, low premiums, favorable insurance terms, less retention

Combined ratio

Paid Losses

+

Loss Adjustment Expenses

+

Underwriting Expenses

/

Premiums

Capacity

the relative level of surplus

Surplus

difference between an insurer's assents and its liabilities

Clash loss

when several lines of insurance simultaneously experience large losses